Six Facts Lost in the IRS Scandal
by Kim Barker and Justin Elliott
ProPublica May 22, 2013
http://www.propublica.org/article/six-facts-lost-in-irs-scandal

In the furious fallout from the revelation that the IRS flagged applications from conservative nonprofits for extra review because of their political activity, some points about the big picture – and big donors — have fallen through the cracks.

Consider this our Top 6 list of need-to-know facts on social welfare nonprofits, also known as dark money groups because they don’t have to disclose their donors. The groups poured more than $256 million into the 2012 federal elections.

1. Social welfare nonprofits are supposed to have social welfare, and not politics, as their “primary” purpose.

A century ago, Congress created a tax exemption for social welfare nonprofits. The statute defining the groups says they are supposed to be “operated exclusively for the promotion of social welfare.” But in 1959, the regulators interpreted the “exclusively” part of the statute to mean groups had to be “primarily” engaged in enhancing social welfare. This later opened the door to political spending.

So what does “primarily” mean?  It’s not clear. The IRS has said it uses a “facts and circumstances” test to say whether a group mostly works to benefit the community or not. In short: If a group walks and talks like a social welfare nonprofit, then it’s a social welfare nonprofit.

This deliberate vagueness has led some groups to say that “primarily” simply means they must spend 51 percent of their money on a social welfare idea — say, on something as vague as “education,” which could also include issue ads criticizing certain politicians. And then, the reasoning goes, a group can spend as much as 49 percent of its expenditures on ads directly advocating the election or defeat of a candidate for office.

Nowhere in tax regulations or rulings does it mention 49 percent, though. Some nonprofit lawyers have argued that the IRS should set hard limits for social welfare nonprofits — setting out, for instance, that they cannot spend more than 20 percent of their money on election ads or even limiting spending to a fixed amount, like no more than $250,000.

So far, the IRS has avoided clarifying any limits.

2. Donors to social welfare nonprofits are anonymous for a reason.

Unlike donors who give directly to politicians or even to super PACs, donors who give to social welfare nonprofits can stay secret. In large part, this is because of an attempt by Alabama to force the NAACP, then a social welfare nonprofit, to disclose its donors in the 1950s. In 1958, the Supreme Court sided with the NAACP, saying that public identification of its members made them at risk of reprisal and threats.

The ACLU, which is itself a social welfare nonprofit, has long made similar arguments. So has Karl Rove, the GOP strategist and brains behind Crossroads GPS, which has spent more money on elections than any other social welfare nonprofit. In early April 2012, Rove invoked the NAACP in defending his organization against attempts to reveal donors.

The Federal Election Commission could in theory push for some disclosure from social welfare nonprofits — for their election ads, at least. But the FEC has been paralyzed by a 3-3 partisan split, and its interpretations of older court decisions have given nonprofits wiggle room to avoid saying who donated money, as long as a donation wasn’t specifically made for a political ad.

New rulings indicate that higher courts, including the Supreme Court, favor disclosure for political ads, and states are also stepping into the fray. During the 2012 elections, courts in two states – Montana and Idaho – ruled that two nonprofits engaged in state campaigns needed to disclose donors.

But sometimes, when nonprofits funnel donations, the answers raise more questions. It’s the Russian nesting doll phenomenon. Last election, for instance, California’s election agency pushed for an Arizona social welfare nonprofit to disclose donors for $11 million spent on two California ballot initiatives. The answer? Another social welfare nonprofit, which in turn got the money from a trade association, which also doesn’t have to reveal its donors.

3. The Supreme Court’s Citizens United decision meant that corporations could pay for political ads, anonymously, using social welfare nonprofits.

In January 2010, the Supreme Court ruled that corporations and unions could spend money directly on election ads. A later court decision made possible super PACs, the political committees that can raise and spend unlimited amounts of money from donors, as long as they don’t coordinate with candidates and as long as they report their donors and spending.

Initially, campaign finance watchdogs believed corporations would give directly to super PACs. And in some cases, that happened. But not as much as anyone thought, and maybe for a reason: Disclosure isn’t necessarily good for business. Target famously faced a consumer and shareholder backlash after it gave money in 2010 to a group backing a Minnesota candidate who opposed gay rights.

Many watchdogs now believe that large public corporations are giving money to support candidates through social welfare nonprofits and trade associations, partly to avoid disclosure. Although the tax-exempt groups were allowed to spend money on election ads before Citizens United, their spending skyrocketed in 2010 and again in 2012.

A New York Times article based on rare cases in which donors have been disclosed, sometimes accidentally, explored the issue of corporations giving to these groups last year. Insurance giant Aetna, for example, accidentally revealed it gave $3 million in 2011 to the American Action Network, a social welfare group founded by former Sen. Norm Coleman, a Republican, that runs election ads.

Groups that favor more disclosure have so far failed to force action by the FEC, the IRS, or Congress, although some corporations have voluntarily reported their political spending. Advocates have now turned to the Securities and Exchange Commission, which is studying a proposal to require public companies to disclose political contributions.

The idea is already facing strong opposition from House Republicans.

4. Social welfare nonprofits do not actually have to apply to the IRS for recognition as tax-exempt organizations.

With all the furor over applications being flagged from conservative groups — particularly groups with “Tea Party,” “Patriot” or “9/12” in their names — it’s worth remembering that a social welfare nonprofit doesn’t even have to apply to the IRS in the first place.

Unlike charities, which are supposed to apply for recognition, social welfare nonprofits can simply incorporate and start raising and spending money, without ever applying to the IRS.

The agency’s nonprofit wing is mainly concerned about ferreting out bad charities, which are the biggest chunk of nonprofits and the biggest source of potential revenue. After all, the IRS’s main job is to collect revenue. Charities allow donors to deduct donations, while social welfare nonprofits don’t.

Most major social welfare nonprofits do apply, because being recognized is seen as insurance against later determination by the IRS that the group should have registered as a political committee and may face back taxes and disclosure of donors. A recognition letter is also essential to raise money from certain donors — like, say, corporations.

But some of the new groups haven’t applied.

The first time the IRS hears about these social welfare nonprofits is often when they file their first annual tax return, not due until sometimes more than a year after they’ve formed.

In many cases, the first time the IRS hears about these groups is a full year after an election.

5. Most of the money spent on elections by social welfare nonprofits supports Republicans.

Of the more than $256 million spent by social welfare nonprofits on ads in the 2012 elections, at least 80 percent came from conservative groups, according to FEC figures tallied by the Center for Responsive Politics.

None came from the Tea Party groups with applications flagged by the IRS. Instead, a few big conservative groups were largely responsible.

Crossroads GPS, which this week said it believes it is among the conservative groups “targeted” by the IRS, spent more than $70 million in federal races in 2012. Americans for Prosperity, the social welfare nonprofit launched by the conservative billionaire brothers Charles and David Koch, spent more than $36 million. American Future Fund spent more than $25 million. Americans for Tax Reform spent almost $16 million. American Action Network spent almost $12 million.

Besides Crossroads GPS, each of those groups has applied to the IRS and been recognized as tax-exempt. (You can look at their applications here.)

All of those groups spent more than the largest liberal social welfare nonprofit, the League of Conservation Voters, which spent about $11 million on 2012 federal races. The next biggest group, Patriot Majority USA, spent more than $7 million. Planned Parenthood spent $6.5 million. VoteVets.org spent more than $3 million.

None of those figures include the tens of millions of dollars spent by groups on certain ads that run months before an election that are not reported to the FEC.

6. Some social welfare groups promised in their applications, under penalty of perjury, that they wouldn’t get involved in elections. Then they did just that.

Much of the attention when it comes to Tea Party nonprofits has focused on their applications and how the IRS determines whether a group qualifies for social welfare status.

As part of our reporting on dark money in 2012, ProPublica looked at more than 100 applications for IRS recognition. One thing we noted again and again: Groups sometimes tell the IRS that they are not going to spend money on elections, receive IRS recognition, and then turn around and spend money on elections

The application to be recognized as a social welfare nonprofit, known as a 1024 Form, explicitly asks a group whether it has spent or plans to spend “any money attempting to influence the selection, nomination, election, or appointment of any person to any Federal, state, or local public office or to an office in a political organization.”

The American Future Fund, a conservative nonprofit that would go on to spend millions of dollars on campaign ads, checked “No”in answer to that question in 2008. The very same day the group submitted its application, it uploaded this ad to its YouTube account:

Even before mailing its application to the IRS saying it would not spend money on elections in 2010, the Alliance for America’s Future was running TV ads supporting Republican candidates for governor in Nevada and Florida. It also had given $133,000 to two political committees directed by Mary Cheney, the daughter of the former vice president.

Another example of this is the Government Integrity Fund, a conservative nonprofit that ran ads in last year’s U.S. Senate race in Ohio. Its application was approved after it told the IRS that it would not spend money on politics. The group went on to do just that.

For more on the IRS and nonprofits active in politics, read our story on how the IRS’s nonprofit division got so dysfunctional, Kim Barker’s investigation, “How nonprofits spend millions on elections and call it public welfare” and our Q&A on dark money.  

Fun take on our uncharted territory via the WSJ

Click to see how global economic forces have affected debt-to-GDP ratios

Source: Real Time Economics

Interactive by Andrew Garcia Phillips, Phil Izzo and Pat Minczeski/The Wall Street Journal

• Slaves to the algorithm: Our age elevates the precision-tooled power of the algorithm over flawed human judgment. This may not be such a good thing (aeon)
• Facebook, One Year Later: What Really Happened in the Biggest IPO Flop Ever (Atlantic)
• The Pseudo-Business of the NCAA (priceonomics)
• Mandelbrot Conceived the Mathematics of Roughness (New York Review of Books) see also Unknown Mathematician Proves Elusive Property of Prime Numbers (Wired)
• Left Behind: No break for the wounded  America does a terrible job of caring for its war veterans (The Gazette)
• Philosopher Daniel Dennett: Seven Tools For Critical Thinking (Open Culture)
• Bret, Unbroken: His brain and body shattered in a horrible accident as a young boy, Bret Dunlap was mess. Then he discovered running. (Runner’s World)
• The Gut-Wrenching Science Behind the World’s Hottest Peppers (Smithsonian)
• End it like Beckham: England legend calls time on glittering career and retires (Daily Mail)
• Welcome to Google Island (Wired)

Whats up for your holiday weekend?

Year-to-date asset class returns

Source: Deutsche Bank via @matthewphilips via Abnormal Returns

Positives:

1. U.S. jobless claims fell 23k to 340k v expectations of 345k.
2. Housing remains a significant tailwind in the U.S. as existing home sales increase 0.6% m/o/m in April to 4.94M units, the highest reading since November 2009.
3. U.S. new home sales rose 2.3% m/o/m in April to 454k versus expectations of 425k.
4. U.S. April Durable goods orders shows a nice beat, showing a rise of 3.3% v expectations of +1.5%.
5. Durable good ex-trans rose 1.3% v expectations of +0.5%
6. Dow Jones had gone a record 100 days without a 3 day losing streak, that was snapped this week (market could use a breather).
7. Despite a very noisy week, the S&P 500 is up >15% YTD, through May!

Negatives:

1. The Nikkei had a violent selloff Wednesday night, selling off 12.5% peak to trough.
2. The 7% overnight down move is the equivalent of 1,117 Dow points. Only the 10th time in the last 50 years the Nikkei declined more than 7% in a single day.
3. Wednesday saw a nasty reversal in the market with the Dow dropping nearly 300 points from the highs of the day to the lows.
4. The S&P 500 had not been up 1%only to finish down 1% since August 2011 (market came off the lows at the end of day to avoid this).
5. China’s May flash PMI comes in at 49.6 v expectations of 50.4, a 7 month low for the worlds second biggest economy, signaling contraction.
6. Japan’s April exports rose 3.8% y/o/y v expectations of 5.4%. C’mon Abe.
7. Secular decline in the PC market is reaffirmed by HP, whose PC sales fell (Wow!) 20% from a year ago.
8. Bernanke had a difficult time communicating the Fed’s intentions. Mr. Market had a difficult time digesting the fact that tapering can begin as early as this summer.
9. U.S. core capital shipments came in light than expected, declining 1.5% m/o/m v expectations or a 0.5% drop.

Thanks, Mike!

Awesome chart from Chris Kimble showing the Nikkei going back to 1982 — in particular, the downtrend that began in 1989 and still persists to this day.

Chris notes that Declines of 32% to 60% taken place at this level for the past 20 years!

One would normally expect a pullback and consolidation after a long move up to a major trendline, and under pre-Abenomics stimulus, that would be my highest probability outcome (pre-stimulus, I have no idea!).

The key here is if and when the Nikkei breaks through that trendline, it is likely the beginning of a longer term multi-year breakout. This is why we put on Japan exposure for clients much earlier this year.

~~~

Disclosure: Clients are long GAL, DXJ, which have substantial exposure to Japan.

• The Smart Money Is Still Bullish (Barron’s)
• Notes from the PIMCO Investment Summit with Mohamed El-Erian (The Reformed Broker) Is this the dumb money?
• With ‘Abenomics,’ Japan catches a sense of revival (WaPo) see also Japan the Model: We are in economic terms, all Japanese (NYT)
• Gold Traders Most Bullish in a Month After Bernanke (Bloomberg)
• The Rules, Part XXXVIII (The Aleph Blog)
• Why pension funds are eating your 401(k)’s lunch (Reuters)
• Tax Two-fer:
…..-In Tax Overhaul Debate, Large vs. Small Companies (NYT)
…..-The Corrosive Effect of Apple’s Tax Avoidance (NYT)
• Four Reasons Housing Recovery Isn’t Yet Boosting Economy (Real Time Economics)
• Android’s Market Share Is Literally A Joke (Tech.pinions)
• Photos: Tornadoes wreak havoc in US (Boston.com’s Big Picture)

What are you reading?

World Shakes Off Nikkei’s 7.3% Plunge

Source: WSJ

• Most Day-to-day market action is noise, There is very little signal involved, with the vast majority of commentary simply after-the-fact rationalizations of what just occurred.

• Over the years, one of the few exceptions that I have found to the daily noise is the IntraDay reversal. After a long move in either direction, followed by a big flip can be significant  (worrisome, if not conclusive).

• Hence, I do pay attention to days like Wednesday that start out strong and end weak. The caveat: All bets are off on FOMC minute days, as we seem to have a big spike in volatility (someone must have done a study on this).

• Never confuse a forecast with an analysis.

• Consider a day that starts out 150 Dow points up (or down) and ending the day down (or up) 150. That 300 point swing is more significant than a down (up) 300 point day. We sometimes see it at major tops and bottoms, as it reflects an exhaustion of one side in the battle of supply and demand. (Candlestick technicians have the data on shooting stars and dojis; if this sort of stuff interests you, then see Steve Nison’s book Japanese Candlestick Charting Techniques).

• Of course, all of this can reflect your biases, holdings, fears and worries. That is why I try to think about issues such as these in the abstract, rather than referencing current positions — to avoid my own b9iases and get stuck int he trap of merely talking my book.

• The alternative is allowing markets to serve as Rorschach tests, reflecting peoples pre-existing investment postures — not what they truly think. This an ongoing pundit problem.

• Be aware of your own timeline — are you a trader or an investor? Then act like it.

• Bears see the intraday reversal (like Wednesday’s) as a very significant change in tone; Bulls see a comeback (like Thursday’s) as proof of a Japanese overreaction to weak China economic news — something inapplicable to the US markets.

• Lately, it seems that markets close the day much stronger than the early morning futures would imply. I’d love to see the actual data on that (Closes vs AM Futures). It is similar to what used to be called the Smart Money Index, something created by Don Hays. (I have no clue if SMI has any insight).

• My key takeaway is that the cognitive bias is immense. Most of the attempts we see to interpret short or even intermediate term market action are often overwhelmingly filled with rationalizations of existing positions.

• Be aware of the tendency to let Narratives obscure the data.

• Raymond James’ Jeff Saut is fond of saying “Where you stand is a function of where you sit.” Meaning, your book often reflects how and what you think.

• So much of what we have learned from the data is counter-intuitive.

• The most challenging thing confronting the vast majority of investors is their inability to make objective, emotion-free decisions based on empirical data. Instincts, hunches and emotions are killers when it comes to the markets.

Identifying the cognitive errors we make is only the first step; Developing a way to respond to them, preventing this aspect of our personalities from affecting investing decisions is an ongoing, indeed, never-ending process.

What are you doing to prevent your biases and emotions  from getting in your own way?

• The Uncertainty of Risk (n+1) see also Adaptation (The Reformed Broker)
• Jonathan Miller: Home Supply Limited by Americans Lacking Equity to Sell (Bloomberg)
• Greenspan’s Market Persists (Alhambra Investment Partners) and How Much of a Dove Is Bernanke, Really? (Businessweek)
• Oil Manipulation Inquiry Shows EU’s Hammer After Libor (Bloomberg)
• The Mirage that is Financial Literacy (money&markets)
• How Nations Tried to Keep Striving Migrants In (Echoes)
• Nocera: Tim Cook’s reality distortion field (NYT) see also Tim Cook’s improbable victory in D.C. (Reuters)
• Is This Big Tea Party Group Really an Innocent Victim of the IRS? (MoJo)
• X-BOX: Steve Jobs’ Dream Device Has Arrived (Slate)
• 10 Novels That Are More Action-Packed Than Most Summer Movies (io9)

Whatcha reading?

America’s Corporation-Tax Receipts Falter Even as Company Profits Soar

Source: Economist

Jeff deGraaf, technician extraordinaire (formerly of Lehman now at Renaissance Macro Research) makes an interesting observation about the heavily overbought markets.

Last week, the S&P500 had ~93% of all stocks trading over their 200 day moving average. Normally, this degree of overbought should lead to a correction. As you can see in the inset box, it sometimes does.

However, if you are looking out a year, we see that over the past 3 instances, markets have been higher.

The takeaway is that you should determine if you are a trader or an investor before thinking about whether to lighten up or add on dips.

Different timelines and holding periods should consider different responses to the volatility.

Note you can get see the updated version of this measure at various places online (Index Indicators, StockCharts, Decision Point. You can read more about this measure here.
 

• Japan’s mini crash: Blame China(FT Alphaville) see also Dumb money returns to Japan (ft.com)
• Extreme Fear (Joe Fahmy)
• Bernanke to Congress: I’m Not the Problem. You Are. (The Fiscal Times) see also Wonkbook: Bernanke lashes Congress (Wonkblog)
• Why Investors Fail (Motley Fool)
• Dudley Says Decision on Taper Will Require 3-4 Months (Bloomberg)
• Investing in Gold: Does It Stack Up? (Knowledge at Wharton)
• Teens are tired of Facebook ‘drama,’ find refuge on Twitter and elsewhere, says Pew (The Verge) see also Teens, Social Media, and Privacy (Pew Internet)
• Six Facts Lost in the IRS Scandal (ProPublica)
• Putting Apple in an Xbox (WSJ) see also The race to a “smart” television is over. Xbox won (pandodaily)
• Inside Google’s Secret Lab (Businessweek)

What are you reading?

Japanese Stocks Fall 7.3% Overnight

Source: WSJ